DP1472 | Market Transparency, Competitive Pressure and Price Volatility

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In this paper we analyse the role of asymmetric information between firms and consumers about market conditions. In standard models of oligopoly informational advantages of firms over customers do not play a role because all prices are observable. When customers are unable to observe all relevant prices in the market, however, they will attempt to infer the level of unobserved prices from those they can observe. This generates an incentive to use price policies to signal the price realizations of rivals. We show that even with arbitrarily low levels of uncertainty about marginal costs of production, equilibrium prices and price variability are strictly higher in a market with private information about costs. We show how firms can exploit this effect to relax competition through information exchange and analyse the role of advertising in such markets.